“What should I do with my money?”
*The following comments are based off of my experience and observations. This represents my opinion only.
Written by: Geoff Burroughs CFP® With the global economic system in turmoil, and the political environment even more uncertain, people everywhere are asking, “What should I do with my money?” Since the elimination of most corporate pensions, people have been forced to rely on their own savings and investments to fund retirement along with other large expenses such as college. When people turn to their brokers or advisors for guidance, they are typically met with, “Stay the course.” “What does that mean? What course am I on? How can I trust that in the end I will be OK? I don’t have confidence in the economy, so how can I make any decisions about my future?” To help with these questions, let’s put a little more framework around them. When the majority of people think of investment options, most look to stocks, bonds, real estate and cash. People normally want all of the upside with none of the down. All of these investment options carry risk. Yes, all, even cash. Therefore, there is no completely safe investment and no simple answer. So, when someone asks me, “What should I do with my money?” I always respond with, “When do you need it?” “Well, my daughter is going to college in 3 years and I am planning to retire in 12.” Based on this scenario, there will be a need for a portion of money in 3 years, and more starting in 12 years. The key is that this individual will need a portion of their money, but not all of it. Most people will agree that it is impossible to time the market (either the stock or housing market), but fail to recognize how important timing is when it comes to your investments. Assuming you agree with this statement, you need to look at what is manageable. Regardless of what happens in the world, if you have done any planning, then you know when you will need to crack your nest egg or dip into your savings to fund large expenses or retirement. Let’s look at investments in the context of planning for retirement. If you retire at age 65, you most likely have been in the workforce for 40 plus years. In addition, the chances are that you are going to live at least 25 plus years in retirement. That is a long time, and you don’t need all of your savings on day one. Think back to when you were a child and had an old
jar where you put your savings to buy a new bike. You had a specific goal and time frame. As you got older, there was the college jar, then the vacation one and so on. Managing your investments is not much different than the savings jar strategy. Instead of looking at your investments as one big jar, look at them as a series of smaller ones. Each jar has a specific purpose with a defined time period. The principle is to fill those jars in a certain amount of time and then put the lid on them. You don’t need to fill the jar beyond capacity. You just need to fill it. So, how does this work to answer the underlying question of how to truly control your risk? Each jar has its own risk profile with its own diversified portfolio. If you are saving for college, and your child is 3 years away from high school graduation, the jar should be close to full
and the risk should be small. If college is in the distant future, the jar will be far from capacity requiring greater savings and/or higher returns. With a longer timeline, your investments can absorb greater price fluctuation allowing for higher level of risk to be taken without jeopardizing the end goal. Although this seems logical, this approach is rarely used. According to Dalbar Inc., over the last 20 years (1990 2010) the S&P 500 index has returned an average of 9.14% per year while the average stock investor has earned 3.83%. Why is that? People tend to rely on their gut when it comes to many things in life. Typically that is a valuable tool, except when it comes to investing. With investing, often times your gut reaction is the opposite of what is most prudent as far as maximizing investment return. When the environment tells you things are bad, that is
“WHAT SHOULD I DO WITH MY MONEY?”
“Look at your 25 plus years of retirement as a series of small jars.”
normally when you need to buy. However, that is when most people sell, which results in a loss. The damage is then magnified because the investor reenters the market once everything is “rosier” and the majority of the gains have been made. So how do you protect yourself from this vicious cycle when it comes to retirement planning? Most people look at retirement as a specific day in time and the money they have on that day has to last them the rest of their life. Instead…. Look at your 25 plus years of retirement as a series of small jars. The first one is for the first 5 years, the next one is for the 10 years to follow, and then there is one for the 10 years after that. Most people would also like to leave some money for family or causes they care about, which could be thought of as a legacy jar. Once your earning days end, you need to distribute your “nest egg” into these jars. Reminder, each jar has a specific goal and timeframe. Because this is designed to last at least 25 years, and inflation must be considered, you are not going to be able to fill each jar at the start. You will need to satisfy the remainder of each jar with income and returns from the underlying investments. Although this sounds a little scary, take a step back, remove the emotions and let’s look at the jars in more detail. Assuming you are a moderate investor here is a “course” that might work for you: Jar 1 The first 15 years of retirement Because this jar needs to be used immediately, you should practically fill it. The only growth you are looking for is that to offset inflation. You want a well diversified portfolio that targets an average annual return of 23%. Jar 2 Years 615 of retirement With at least 5 years before you need to open this jar, you have a reasonable amount of time to fill it. A lot can happen in 5 years, so you don’t want to take on too much risk, but you will need some. Your goal is for mild growth beyond inflation, so a portfolio targeting a return of 56% is a good objective for this jar. Jar 3 Years 1625 plus
With a time horizon of more than 15 years, this jar requires far less funding at the beginning and should rely more on compounding returns over time. Growth of 78% is a good target since you have a longer timeframe to absorb any major market corrections. Legacy jar Since this is the gravy jar and designed to never be tapped, this should be the least funded and the most reliant on total returns. Again, the goal is to fill each jar with as little risk as possible, and once it is full, put the cap on it. If you are able to fill a particular jar ahead of time, then all of the excess should be moved to one of the other, less full jars. The strength of this approach is that it puts your retire ment distribution into a more specific context. In addition, by rebalancing your jars along the way, meaning you take the excess in one and move it to the next, it allows you to build a constant 5 year cushion in your portfolio. With a 5 year horizon, you can remain an investor and less concerned about the daily movements of the market. Remember, Warren Buffett is in his 80’s and I still consider him a longterm investor. So how does this help in today’s environment? Going back to the average investor versus the stock market, emotion tends to play a destructive part in investment returns. A few questions to keep in mind: Would you feel differently if you knew you had at least 5 years for the market to recover? Do you think you would be less likely to make a gut decision and pull your investments out of the market? Could you feel more comfortable about making decisions with regard to your future with this type of structure? By building in protection from your own emotions, it will allow for a clearly thought out assessment to be made. When it comes to retirement management, a clear mind will dramatically improve your chance of success. Morgan Stanley Smith Barney LLC. Member SIPC.
S&P 500 Index is an unmanaged, market valueweighted index of 500 stocks generally representative of the broad stock market. An investment cannot be made directly in a market index. Rebalancing does not protect against a loss in declining financial markets. There may be a potential tax implication with a rebalancing strategy. Please consult your tax advisor before implementing such a strategy. The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley Smith Barney or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results.
Published on Oct 26, 2011
This quarter, Mr. Burroughs's newsletter comes to you in a slightly different structure. Morgan Stanley Smith Barney’s Global Investment Co...